Kneejerk responses are not solutions

Over the last week, editorial writers have correctly denounced the governments decision to suspend futures trading in urad and tur as a retrograde move. Policy reversals indeed send negative signals, but often the seeds of such reversal are part of faulty policy-making or supervision. Commodity traders and arbitrageurs are understandably furious at the ban, but claiming they were shocked suggests that they do not have their ear to the ground and that is bad for any trader.

Over the last six months or more, the relentless rise in prices of food grain, pulses and other essentials, including milk and vegetables has had the government in a tizzy. A series of policy measures as well as de-hoarding drives were initiated prior to the drastic decision to suspend futures trading in two commodities. For instance, the export of wheat and pulses is stopped and imports are now duty free. After the controversy over excessive speculation in maize (especially regarding the role of a capital market scam-accused), imports were made duty-free last Thursday.

Similar checks were experimented with and abandoned in case of sugar. However, with inflation edging past 6%, the government had to pay attention to politicians cutting across party lines who blame the satta bazaar or futures market for rising prices. In a democracy that is heading for important State elections, perception is as important as reality; so when Congress Chief Ministers also argued for a ban, tur and urad got the axe while wheat had a narrow escape.

The specific choice of tur and urad may seem debatable at the moment since spot prices are higher than future prices. However, with the area under cultivation for pulses having declined steadily (especially for tur), the consequent shortages and dependence on imports was bound to push up prices. So the ban may end up as a preventive action.

Having said that, unbridled speculation in the commodity markets has long been a cause of concern. It is also evident that despite a 40-year ban, the government rushed to re-start futures trading without fully examining its implications or putting in place the requisite regulatory structure, market infrastructure and information systems needed to bring various stakeholders onto the trading platform.

There has been a lot of talk about commodities futures allowing farmers to improve price realisation and companies using this market to hedge their price risk; but most of that is still mere talk. While we have gone ahead and started three sophisticated commodity markets, commodity price information does not reach farmers or even the mandis (markets) as efficiently as it should, despite efforts by leading bourses to improve price dissemination systems and educate farmers. Even today, market participants admit that an overwhelming portion of trading volume is purely speculative (some put it at 99%) and participation by other stakeholders is negligible. Several counters remain illiquid, settlements are in cash and the delivery mechanism leaves much to be desired. Warehousing Receipts (WR) are still not negotiable and a standing committee report has expressed fears that making them negotiable will increase the risk of fraud. This is probably the outcome of a recent incident where fraudulent WRs without underling physical stock have been caught. Market participants also agree that WRs need a proper regulatory framework and accreditation system.

There is talk about commodities futures allowing farmers to improve price realisation and companies hedging their price risk; but most of that is mere talk

That is not all. Some time in May last year, a parliamentary committee also recommended a ban on futures trading after a controversy erupted over the manner in which NCDEX (the second largest multi-commodity futures bourse) had changed the contract terms for urad and chana without the regulators consent. The outcome of investigation into the incident is still hazy; but it is difficult to argue that rising prices have nothing to do with speculation. Then there is guar seed, which has seen such unbridled speculation that trading volumes have at times been 240 times the production of this edible gum that finds application in ice-cream and confectionery.

In addition to all these indicators of an imperfect price discovery mechanism, there are reports about traders resorting to hoarding and off-market transactions to drive up prices.

To my mind, the increase in dabba trades in the equity market and now commodity market should have been an anticipated consequence of the growing sophistication, regulation, automation and transparency of our exchanges. These bourses, with all their myriad norms, are keeping out a certain kind of trader/investor. So long as black money keeps sloshing around and corruption persists, traders with undeclared income are bound to patronise bucket shops or dabba trading centres to participate in the markets. Even in the equity market, the dabba trading centres have grown and mushroomed, but have quietly slipped out of the regulators radar. Several investors who are tired of the multiple entry barriers of official markets prefer dabba trading where settlements are still based on official market prices.

The casino-like dabba trading in equity markets is relatively harmless. At worst, it hurts investors who make or lose money. But when powerful traders control similar bucket shops in the commodity area, they can drive up prices by hoarding goods and creating artificial shortages.

Tackling this requires a systemic solution and an understanding of market forces rather than a short-term ban on a couple of commodities.